SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

FORM 10-Q

 

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check One):

As of October 29, 2014, 79,700,000May 5, 2015, 79,708,888 common limited partner units of the registrant were outstanding.

CAUTIONARY STATEMENT REGARDING FORWARD-LOOKING STATEMENTS

See accompanying notes to consolidated financial statements.

The lenders may accelerate all of the indebtedness under the Partnership’s revolving credit facilityagreement upon the occurrence and during the continuance of any event of default. The credit agreement contains customary events of default, including non-payment, breach of covenants, materially incorrect representations, cross-default, bankruptcy and change of control. There are no cure periods for events of default due to non-payment of principal and breaches of negative and financial covenants, but non-payment of interest and breaches of certain affirmative covenants are subject to customary cure periods.

Effective September 19, 2013, the Predecessor issued a subordinated note to Diamondback for the principal sum of $440.0 million for thea royalty interest acquisition discussed in Note 3.acquisition. In connection with the IPO, the subordinated note was converted to equity. The note bore interest at 7.625% per annum. Interest was due and payable monthly in arrears on the first business day of each calendar month. The unpaid principal balance and all accrued interest on the note were due and payable in full on October 1, 2021. Any indebtedness evidenced by this note was subordinate in the right of payment to any indebtedness outstanding under the Diamondback revolving credit facility. Prior to the completionagreement. As of the IPO,March 31, 2014, there was $437.1$444.1 million of principal and interest outstanding under this note. We owed $9.7 million of accrued interest as of December 31, 2013, which is included in accounts payable—related party in the accompanying balance sheets.

In connection with the closing of the IPO, the General Partner and Diamondback entered into the first amended and restated agreement of limited partnership (the “Partnership Agreement”), dated June 23, 2014.

The Partnership Agreement requires usthe Partnership to reimburse the General Partner for all direct and indirect expenses incurred or paid on ourthe Partnership’s behalf and all other expenses allocable to usthe Partnership or otherwise incurred by ourthe General Partner in connection with operating ourthe Partnership’s business. The Partnership Agreement does not set a limit on the amount of expenses for which ourthe General Partner and its affiliates may be reimbursed. These expenses include salary, bonus, incentive compensation and other amounts paid to persons who perform services for usthe Partnership or on ourthe Partnership’s behalf and expenses allocated to ourthe General Partner by its affiliates. OurThe General Partner is entitled to determine the expenses that are allocable to us.the Partnership. For the three months and nine months ended September 30, 2014, we reimbursed ourMarch 31, 2015, no expenses were allocated to the Partnership by the General Partner $750,000 and $750,000, respectively.Partner. At September 30, 2014, we owed ourMarch 31, 2015, the Partnership had no outstanding amounts payable to the General Partner no amounts.Partner.

Advisory Services Agreement

In connection with the closing of the IPO, the Partnership and General Partner entered into an advisory services agreement (the “Advisory Services Agreement”) with Wexford Capital LP (“Wexford”), Diamondback’s equity sponsor, dated as of June 23, 2014, under which Wexford provides usthe Partnership and ourthe General Partner with general financial and strategic advisory services related to ourthe Partnership’s business in return for an annual fee of $500,000, plus reasonable out-of-pocket expenses. The Advisory Services Agreement has a term of two years commencing on June 23, 2014, and will continue for additional one-year periods unless terminated in writing by either party at least ten days prior to the expiration of the then current term. It may be terminated at any time by either party upon 30 days prior written notice. In the event we terminate such agreement, we arethe Partnership terminates the Advisory Services Agreement, the Partnership is obligated to pay all amounts due through the remaining term. In addition, we havethe Partnership has agreed to pay Wexford to-be-negotiated market-based fees approved by the conflict committee of the board of directors of ourthe General Partner for such services as may be provided by Wexford at ourthe Partnership’s request in connection with future acquisitions and divestitures, financings or other transactions in which wethe Partnership may be involved. The services provided by Wexford under the Advisory Services Agreement do not extend to ourthe Partnership’s day-to-day business or operations. We haveThe Partnership has agreed to indemnify Wexford and its affiliates from any and all losses arising out of or in connection with the Advisory Services Agreement except for losses resulting from Wexford’s or its affiliates’ gross negligence or willful misconduct. For the three months and nine months ended September 30, 2014,March 31, 2015, we incurred costs of $143,000 and $143,000, respectively,$125,000, under the Advisory Services Agreement. At September 30, 2014, we owed WexfordMarch 31, 2015, there were no amounts.

Effective September 19, 2013, the Predecessor entered into a shared services agreement with Diamondback E&P LLC, a wholly ownedwholly-owned subsidiary of Diamondback Energy, Inc.Diamondback. This agreement was terminated in connection with the IPO. Under this agreement, Diamondback E&P LLC provided consulting and administrative services to the Predecessor. The Predecessor incurred a monthly charge for the services of $26,000. For the ninethree months ended September 30,March 31, 2014, and for the period from inception (September 18, 2013) to December 31, 2013, wePartnership incurred costs under this agreement of $156,000 and $87,000, respectively. At December 31, 2013, the Partnership owed Diamondback E&P LLC $87,000, which is included in accounts payable—related party in the accompanying balance sheets.$78,000.

11.9.    COMMITMENTS AND CONTINGENCIES

12.10.    SUBSEQUENT EVENTS

On November 4, 2014,May 1, 2015, the Boardboard of Directorsdirectors of ourthe General Partner approved a cash distribution attributable tofor the period from June 23, 2014 through September 30, 2014first quarter of $0.252015 of $0.19 per common unit, payable on November 28, 2014,May 22, 2015, to unitholders of record at the close of business on November 21, 2014.May 15, 2015.

ITEM 2.         MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

The following discussion and analysis should be read in conjunction with our unaudited consolidated financial statements and notes thereto presented in this Quarterly Report on Form 10–Q10-Q as well as our audited consolidated financial statements and notes thereto included in our final prospectus dated June 17,Annual Report on Form 10-K for the year ended December 31, 2014 and filed with the SEC pursuant to Rule 424(b) under the Securities Act, on June 18, 2014.. The following discussion contains “forward-looking statements” that reflect our future plans, estimates, beliefs, and expected performance. Actual results and the timing of events may differ materially from those contained in these forward-looking statements due to a number of factors. See “Part II,II. Item 1A. Risk Factors” and “Cautionary Statement Regarding Forward-Looking Statements.”

Overview

We are a publicly traded Delaware limited partnership formed by Diamondback on February 27, 2014 to, among other things, own, acquire and exploit oil and natural gas properties in North America. The Partnership is currently focused on oil and natural gas properties in the Permian Basin. As of September 30, 2014,March 31, 2015, the General Partnergeneral partner held a 100% non-economic general partner interest in the Partnership,us, and Diamondback had an approximate 88%88.4% limited partner interest in the Partnership.us. Diamondback also owns and controls the General Partner.general partner.

Recent Developments

Public Offerings

Prior to the completion of our IPO on June 23, 2014, of our IPO of 5,750,000 common units representing limited partner interests, Diamondback owned all of the general and limited partner interests in the Partnership.us. On June 23, 2014, we completed our IPO of 5,750,000 common units representing limited partner interests at a price to the public of $26.00 per common unit, which included 750,000 common units issued pursuant to an option to purchase additional common units granted to the underwriters on the same terms. We received net proceeds of approximately $137.2 million from the sale of these common units, net of offering expenses and underwriting discounts and commissions.

On September 19, 2014, the Partnershipwe completed an underwritten public offering of 3,500,000 common units. The common units were sold to the public at $28.50 per unit and the Partnershipwe received net proceeds of approximately $95.1$94.8 million from the sale of these common units, net of offering expenses and underwriting discounts and commissions.

Sources of Our Revenue

Royalty Income

General and Administrative Expenses

Adjusted EBITDA

    

Adjusted EBITDA is used as a supplemental non-GAAP financial measure by management and external users of our financial statements, such as industry analysts, investors, lenders and rating agencies. We believe Adjusted EBITDA is useful because it allows us to more effectively evaluate our operating performance and compare the results of our operations period to period without regard to our financing methods or capital structure. In addition, management uses Adjusted EBITDA to evaluate cash flow available to pay distributions to our unitholders.

We define Adjusted EBITDA as net income (loss) plus interest expense, net of capitalized interest, non-cash unit-based compensation and depletion expense. Adjusted EBITDA is not a measure of the income (loss) as determined by United States’ generally accepted accounting principles, or GAAP. We exclude the items listed above from net income (loss) in arriving at Adjusted EBITDA because these amounts can vary substantially from company to company within our industry depending upon accounting methods and book values of assets, capital structures and the method by which the assets were acquired. Certain items excluded from Adjusted EBITDA are significant components in understanding and assessing a company’s financial performance, such as a company’s cost of capital and tax structure, as well as historic costs of depreciable assets, none of which are components of Adjusted EBITDA.

Adjusted EBITDA should not be considered an alternative to net income, royalty income, cash flow from operating activities or any other measure of financial performance or liquidity presented in accordance with GAAP. Our computations of Adjusted EBITDA may not be comparable to other similarly titled measures of other companies.

The following table presents a reconciliation of Adjusted EBITDA to net income, our most directly comparable GAAP financial measure for the periods indicated.

Liquidity and Capital Resources

Our partnership agreement does not require us to distribute any of the cash we generate from operations. We believe, however, that it will be in the best interests of our unitholders if we distribute a substantial portion of the cash we generate from operations. The board of directors of our General Partner will adoptgeneral partner has adopted a policy to distribute an amount equal to the available cash we generate each quarter to our unitholders. Our first distribution, however, will include available cash forOn February 5, 2015, the period from June 23, 2014, the dateboard of directors of the closingGeneral Partner approved a cash distribution attributable to the fourth quarter of the IPO, through September 30, 2014.2014 of $0.25 per unit, which was paid on February 27, 2015. This distribution included a total of $17.6 million distributed to Diamondback. Cash distributions will be made to the common unitholders of record on the applicable record date, generally within 60 days after the end of each quarter. Available cash for each quarter will be determined by the board of directors of our General Partergeneral partner following the end of such quarter. Available cash for each quarter will generally equal Adjusted EBITDA reduced for cash needed for debt service and other contractual obligations and fixed charges and reserves for future operating or capital needs that the board of directors of our General Partnergeneral partner deems necessary or appropriate, if any.

On July 8, 2014, we entered into a $500.0 million secured revolving credit agreement with Wells Fargo as the administrative agent, sole book runner and lead arranger. The credit agreement, which was amended August 15, 2014 to add additional lenders to the lending group, matures on July 8, 2019. As of September 30, 2014,March 31, 2015, the borrowing base was set at $110.0 million. Wemillion and we had no outstanding borrowings asborrowings. In connection with our Spring 2015 redetermination, the agent lender under the credit agreement has recommended that our borrowing base be increased to $175.0 million. This increase is subject to the approval of September 30, 2014.our other lenders.

The outstanding borrowings under the credit agreement bear interest at a rate elected by us that is equal to an alternative base rate (which is equal to the greatest of the prime rate, the Federal Funds effective rate plus 0.5% and 3-month LIBOR plus 1.0%) or LIBOR, in each case plus the applicable margin. The applicable margin ranges from 0.5% to 1.50% in the case of the alternative base rate and from 1.50% to 2.50% in the case of LIBOR, in each case depending on the amount of the loan outstanding in relation to the borrowing base. We are obligated to pay a quarterly commitment fee ranging from 0.375% to 0.500% per year on the unused portion of the borrowing base, which fee is also dependent on the amount of the loan outstanding in relation to the borrowing base. Loan principal may be optionally repaid from time to time without premium or penalty (other than customary LIBOR breakage), and is required to be paid (a) if the loan amount exceeds the borrowing base, whether due to a borrowing base redetermination or otherwise (in some cases subject to a cure period) and (b) at the maturity date of July 8, 2019. The loan is secured by substantially all of the assets of the Partnershipour and its subsidiaries.our subsidiaries’ assets.

The covenant prohibiting additional indebtedness allows for the issuance of unsecured debt of up to $250.0 million in the form of senior unsecured notes and, in connection with any such issuance, the reduction of the borrowing base by 25% of the stated principal amount of each such issuance. A borrowing base reduction in connection with such issuance may require a portion of the outstanding principal of the loan to be repaid.

The lenders may accelerate all of the indebtedness under the Partnership’s revolvingour credit facilityagreement upon the occurrence and during the continuance of any event of default. The credit agreement contains customary events of default, including non-payment, breach

of covenants, materially incorrect representations, cross-default, bankruptcy and change of control. There are no cure periods for events of default due to non-payment of principal and breaches of negative and financial covenants, but non-payment of interest and breaches of certain affirmative covenants are subject to customary cure periods.

Cash Flows

Credit Risk